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Solving Greenwashing: A complex problem with a simple solution

The Impaakt Team

10 min Read Time | July 31st 2023

The Context

The democratization of ESG (Environmental, Social, and Governance) within the financial sector has resulted in a significant increase in the number of products and services being marketed as "sustainable." However, this proliferation of terminologies, along with the lack of standardization and excessive marketing, has raised doubts regarding the actual sustainability claims and the sincerity of asset managers. The accusations of greenwashing have multiplied, with mainstream media expressing surprise at the inclusion of certain companies, which are, at the very least, counterintuitive, among the top holdings of funds being presented as "green" or "sustainable."

Why it’s an essential problem

Whether contested or accepted, these accusations of greenwashing must be taken very seriously as they undermine investor confidence and risk rendering the crucial efforts of the financial industry's sustainable transition futile. It is essential that we change the current investment landscape, and this goal cannot be achieved if investors turn away from the green funds available to them. Regulators have recognized the issue and have made attempts, albeit with limited success thus far, to restore order and confidence in sustainable finance.

Nevertheless, it is primarily the responsibility of the financial sector itself to address this problem, considering the significant stake it has in preserving trust. Such a solution necessitates a comprehensive understanding of the multifaceted and complex nature of greenwashing in order to apply appropriate remedies to the various issues at hand.

Where does the problem come from?

There are three primary categories of greenwashing:

1. Greenwashing by Intention

This category is the most reprehensible of the three, although it may not be the most prevalent. It involves employing marketing tactics to portray something as environmentally friendly when it is actually not, or only minimally so. This can include showcasing a few commendable initiatives while disregarding the larger context, such as adding wind turbines to a site while the majority of their services remain conventional and heavily tied to the fossil fuel industry. Greenwashing of this nature is not exclusive to the financial sector; it can be found across all industries and may even border on false advertising. Such greenwashing practices are highly unacceptable, and regulatory measures aim to primarily eliminate them. Hopefully, the fines imposed on institutions caught red-handed will serve as examples and deter these abuses from continuing.

2. Greenwashing by Execution

This category pertains to asset managers who genuinely prioritize sustainability and have made considerable investments in sustainability research capabilities. Unfortunately, despite these efforts, they often struggle to tangibly influence the composition of their portfolios. Sustainability research teams are typically separate from investment teams, and the final decisions rest with managers whose primary focus, and compensation, is primarily tied to financial performance. As a result, lofty speeches are quickly met with the realities of market demands, which may not align with sustainability objectives in terms of time horizons. Consequently, while banks may produce numerous analyses and recommendations regarding "Net-Zero" initiatives or the imperative of decarbonizing portfolios, in practice, some have significantly increased their exposure to the oil sector over the past couple of years to capitalize on sectoral growth. To bridge the gap between sustainable convictions and portfolio realities, a fundamental cultural shift within the financial sector is necessary. Such a shift can only be achieved through the influence of end customers and should involve a remuneration system for managers that integrates sustainable performance as a key factor.

3. Greenwashing through Misconception

This category represents the most prevalent and yet least comprehended form of greenwashing. It arises from a significant "disconnect" that has emerged between the financial community and end customers (individual investors or pension fund beneficiaries) over the past decade, coinciding with the rise of ESG. Banks have frequently presented ESG ratings to their clients as a measure of sustainability. In essence, the notion has been conveyed that a company with a high ESG score equates to a sustainable company, and consequently, an ESG fund equates to a sustainable fund. Unfortunately, this perception is flawed.

ESG approaches were never designed to assess a company's environmental impact. On the contrary, their primary objective is to evaluate the potential impacts that the environment could have on the company. These approaches serve as risk management tools developed by investment specialists for investment specialists. Therefore, the ESG approach aims to determine whether investing in a company like Coca-Cola, for example, is advantageous for the investor, rather than assessing its impact on the planet, which is the realm of impact measurement.

This is why Coca-Cola receives an AAA rating in MSCI's ESG rating system, the leading global provider of ESG data. MSCI's analysis indicates that Coca-Cola does not pose a risk to the investor in terms of governance, environmental, and social factors. However, this does not imply that Coca-Cola, one of the world's largest contributors to plastic pollution and obesity, can be deemed an AAA-rated company when it comes to promoting environmental or social improvements.

This confusion has been perpetuated by the banking sector over the past fifteen years, often due to bankers' lack of understanding rather than a deliberate attempt to mislead their clients. Many professionals in the industry still believe that ESG equates to sustainability and continue to endorse ESG funds as sustainable solutions. However, end clients, who find companies like Coca-Cola or Shell listed as "ESG leaders" in their portfolios, understandably struggle to comprehend how these companies contribute to a greener and more equitable planet. It is now crucial to instill rigor within the industry and develop impact products alongside ESG products, as these are the types of products that clients are currently seeking.

How to solve greenwashing and restore end-client trust

While the issue of greenwashing is intricate and multifaceted, its solution can be straightforward. The crucial step lies in placing end clients, who have largely been excluded from sustainable finance for the past fifteen years, at the core of evaluation methodologies. Establishing a sustainability rating system that draws input from clients themselves and civil society as a whole is the most effective means to address accusations of greenwashing. Current proprietary approaches, where financial companies develop ESG ratings using often opaque methodologies, are inadequate in restoring lost trust. Conversely, adopting a participatory and citizen-driven approach that is rigorous and structured holds the greatest potential for gaining acceptance from end clients, a factor that is currently lacking. This acceptance stands as one of the fundamental keys to successfully addressing the immense challenge of sustainable transition, and it is the mission undertaken by Impaakt.


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